Election poses fresh challenge for Reg BI

Broker-dealers are starting to implement changes in how registered reps and advisers charge clients in the wake of Regulation Best Interest, which took effect in June, with some firms currently overhauling certain fees and charges to clients.

That is to be expected, particularly after a revamping of industry rules of the magnitude of Reg BI.

Jay Clayton, head of the Securities and Exchange Commission, said at an Oct. 19 industry meeting that financial advisers who are dual registrants (meaning they charge fees in advisory accounts and commissions in brokerage accounts) understand that they must know their customers and follow policies intended to curb conflicts of interest.

Indeed, broker-dealer executives and securities regulators are using buzz words like transparency and disclosure when discussing the changes to fees and charges made under the SEC’s new rule, which is supposed to ensure that financial professionals registered as investment advisers and brokers act in their clients’ best interests.

“The dual-hatted investment professional — the investment adviser-broker dealer who’s now subject to [Reg BI] — is finding out that while the compensation models are different … the standard you owe your customer is very much the same,” Clayton said at a virtual conference. “You’re seeing it in the disclosures.”

That’s all well and good, at least for the present moment and immediate future. But just as the broad retail financial advice industry settles into operating under the new regime, will the Reg BI system last in its current form if former Vice President Joe Biden wins the White House?

Remember, Reg BI came after the current Republican administration of President Donald Trump moved to erase the Department of Labor’s fiduciary rule, part of former President Barack Obama’s legacy. The retail financial advice and securities industries despised the DOL fiduciary rule, so Trump’s election in 2016 was a clear win for their interests. The biggest critiques of the DOL fiduciary rule were that it was expensive, would punish brokers who charged commissions and left firms wide open to costly attacks from the plaintiff’s bar.

The election takes place Tuesday, a few days after this story was first published online at InvestmentNews.com, and Joe Biden has consistently led in a number of polls. Will a change from a Trump to a Biden administration signal more regulatory uncertainty regarding how advisers charge clients for brokerage assets and advisory accounts?  What will happen if figures that Wall Street particularly loathes (think Sen. Elizabeth Warren, D- Mass.) are given prominent roles?

“The wild card with Reg BI right now is not what it says but how it is enforced,” said John Rooney, managing principal at Commonwealth Financial Network, a large independent broker-dealer and RIA platform. “If you want to weaponize Reg BI like some ideologues on the left do, then it’s likely you will have to reassess to meet their dictate.”

“The big question to ask is who ends up in power in a potential Biden administration,” Rooney said. “Will it be pragmatists or hardened ideologues who will advance an agenda regardless of the unintended consequences it may reap? I don’t think we know that right now.”

FEE JOCKEYING 

The financial advice industry and broker-dealers that sell or recommend products are constantly jockeying on fees, with the great fear being that advisers’ ability to charge in the neighborhood of 100 basis points — meaning 1% — of a client’s assets may decrease in the coming decade.

Pricing and pressures on fees are without a doubt on the minds of senior brokerage executives. Last year, after discount brokers cut commissions to zero for certain trades, Morgan Stanley CEO James Gorman said it was valid to speculate about whether there will be increased pressure on advisory fees in the future.

“You are rightly questioning will there be pricing pressure on advice,” Gorman said in response to a question from an analyst during a conference call last fall. “I mean, at the level clients are paying, I think it’s mid-70 basis points for advice on dollars of assets — it’s a great value question. The advice pricing holds up as long as your clients are getting value.”

MUTUALLY EXCLUSIVE

Looking over their shoulders at the mutual fund industry, advisers see an industry that has seen fees pushed down radically over the past 20 years because of dirt cheap exchange-traded funds. While the fees financial advisers charge clients have eroded over the past two decades in the range of 15% to 20%, those fees for financial advice are not under the intense pressure experienced by mutual funds — at least not yet.  

“Advisers’ fees have come down, and advisers have to do more to show they are earning fees,” said Eric Schwartz, executive chairman, at Cambridge Investment Research Inc., another large independent broker-dealer and RIA platform. “So it’s kind of two contrary trends.”   

“Advisers are doing more than they used to do. They are not just divvying up clients’ accounts into four mutual funds,” he said. “Some firms now have an in-house accountant or operate more like a family office for a much smaller scale of client, not just for those with $100 million. The best advisers could potentially raise fees if they add value.”  

FORCING BIG CHANGES 

The DOL fiduciary rule drove brokerage firms to propose big changes in mutual fund pricing.  

For example, in 2016, months before the surprise election of Donald Trump, Merrill Lynch and Commonwealth Financial Network said they were banning commissions in retirement accounts and replacing them with advisory fees. After a federal appeals court in 2018 struck down the Department of Labor’s rule, both firms continued to allow commission-based business. Other firms made similar proposals to flatten mutual fund commissions to avoid potential conflicts. 

Reg BI is currently pushing larger broker-dealer to alter fees and pricing, though not to the degree of the defunct DOL fiduciary rule. 

Pointing to Reg BI, Avantax Investment Services Inc., which caters to advisers who are tax pros, is in the process of levying a new $60 annual fee for advisers’ accounts at outside money managers, a popular way for advisers to conduct business directly with mutual fund companies like American Funds. 

And starting in October, UBS changed its billing for fee-based advisory accounts in the Americas, moving  to daily averaging from quarterly in the arrears. This was done “in the context of Reg BI,” said a person familiar with UBS who asked not to be named, and took into consideration best practices, billing and communication with clients. 

“There’s an ongoing criticism that Reg BI does not say what is in the best interest of the customer,” said A. Valerie Mirko, a partner at Baker & McKenzie. “The impact I would expect with a Democratic-majority SEC would be to examine that, based on the two Democratic commissioners there now.” 

“That means, potentially, formal guidance which is more explicit and eventually puts brighter lines in place that would have a greater impact on pricing,” she said. 

A FINE MESS

Also worrisome for brokerage executives and advisers if Democrats win, at least in the short term, is the potential surge in fines and restitution firms could face in the wake of enforcement investigations carried out under a new regime. While the Trump administration was clearly pro-business and focused on deregulation and cutting corporate income taxes, what new penalties might a Democratic-led SEC or Treasury Department assess? 

If the Democrats take the presidency and the Senate and keep the House, it would not be surprising if regulators ramped up activity, industry executives said. That’s the expectation. 

“Regardless who wins, the industry will focus on better disclosure of fees,” Cambridge Investment’s Schwartz said. “We’ll be trying to think ahead of time what could be considered improper five or 10 years from now, not what was improper in the past.”